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Limitations on State and Local Tax Deductions

January 18, 2018SC&H Group

The new Tax Cuts & Jobs Act (TCJA) was signed into law on December 22, 2017, and is effective beginning with the 2018 tax year. Over the coming weeks, SC&H Group will walk taxpayers through specific topics addressed in the bill − and how changes may directly impact you − in a new blog series. We kick off this series discussing the impact of state and local tax (SALT) limitations below.

Tax reform continues to be a hot topic of conversation in the new year. TCJA will impact many individuals by placing limitations on itemized deductions of various kinds of nonbusiness taxes.

As a result of the new changes, many taxpayers who currently itemize deductions may use the increased standard deduction going forward. This is particularly true for those individuals whose largest deduction was comprised of state and local taxes.

However, for tax years 2018 through 2025, TCJA limits deductions for taxes paid by individual taxpayers in two ways:

$10,000 Deduction Limitation: It limits the aggregate deduction for state and local real property taxes; state and local personal property taxes; state and local, and foreign, income, war profits, and excess profits taxes; and general sales taxes (if elected) for any tax year to $10,000 ($5,000 for married couples filing separately).

Important exception: The $10,000 limit doesn’t apply to: (i) foreign income, war profits, excess profits taxes; (ii) state and local, and foreign, real property taxes; and (iii) state and local personal property taxes if those taxes are paid or accrued in carrying on a trade or business or in an activity engaged in for the production of income.

No Deduction for Foreign Real Property Taxes:It completely eliminates the deduction for foreign real property taxes unless they are paid or accrued in carrying on a trade or business or in an activity engaged in for profit.

To prevent avoidance of the $10,000 deduction limit by prepayment in 2017 of future taxes, the TCJA treats any amount paid in 2017 for a state or local income tax imposed for a tax year beginning in 2018 as paid on the last day of the 2018 tax year. So an individual may not claim an itemized deduction in 2017 on a prepayment of income tax for a future tax year in order to avoid the $10,000 aggregate limitation.

Interestingly enough, the final version of the TCJA was silent regarding the deductibility of prepaid property taxes while it specifically addressed the prepayment of state and local income tax. However, on December 27, 2017, just days before the year end, the IRS issued an advisory statement providing guidance on what prepayments would be deductible in 2017. In a further attempt to prevent avoidance of the new limitation, the IRS concluded that prepayments of 2018 real property tax in 2017 will be deductible only if they have been assessed prior to 2018.

Before making any final decisions, we always recommend that you consult with your tax advisor to review options based on your situation. Please contact us if you have any questions as you navigate 2018 tax planning.